Tanauan Institute, Inc.

– Senior High School Department

TANAUAN INSTITUTE, INC.

Senior High School Department

Modified Learning Scheme : Workbook

Fundamentals of Accountancy, Business, and Management 2
1st Semester, S.Y. 2020-2021
Subject Teacher: ____________________

Name: ___________________________________ Score: ________________

Section: __________________________________ Date: _________________

Topic Session

Merchandising Operation Chapter 5

Objectives of the Lesson

At the end of the lesson, the student should be able to:

1. Describe the difference between service business operation and
merchandising business operation.
2. Identify the source documents in a merchandising business.
3. Differentiate and compute the discount, terms, and payment date of a
credit transaction in a merchandising business.

Values Integration
Perseverance. The attitude that no matter an issue or a problem maybe
one will still continue until he or she succeeds. The lesson that will be
discussed involves analytical thinking which will require the perseverance
of the students in order to learn it.

Discussion
Operating Cycle of a Merchandising Business
The merchandising entity purchases inventory sells the inventory and uses the cash to
purchase more inventory – and the cycle continues.
For cash sales, the cycle is from cash to inventory and back to cash.

Subject: CASH Topic: Purchases

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Cash Sales Inventory

For sales on account, the cycle is from cash to inventory to account receivable and back
to cash:

Cash Purchase Inventory

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Accounts
In any, Receivable
industry, the manager strives to shorten the cycle. The faster the sale of
inventory and the collection of cash, the higher the profits.
Comparison of Income Statements
Service entities perform services for a fee. In contrast, merchandising entities earn profit
by buying and selling goods. These entities use the same basic accounting methods as
service entities, but the process of buying and selling merchandise requires some
additional accounts and concepts.
This process results in a more complex statement. To provide a better measure of
performance, the income statement of a merchandising business is presented with
additional items:

Service Merchandising
Income Statement Income Statement

Revenue from Services Net Sales

Minus
Cost of Sales
Minus equals
Gross Profit
Add or Minus
Expenses Income or Expenses
(see details below)

equals equals
Profit Profit

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Figure 4.1 – Components of Income Statements for

Service and Merchandising Entities

In a merchandising business, net sales arise from the sale of goods while cost of sales
or cost of goods sold represents the cost of inventory the entity has sold to customers.
The difference between net sales and cost of sales is called gross profit. Then other
operating income is added and operating expenses (like distribution costs,
administrative expenses and other operating expenses) are deducted from gross profit
to arrive at operating profit. Investment revenues, other gains and losses, and finance
costs (e.g. interest expense) are considered to arrive at profit before tax then income
tax expense is deducted to have profit from continuing operations (net of tax) is taken to
account to get profit for the period.
Theodore Calaguas Traders
Income Statement
For the Year Ended Dec. 31, 2016

Net Sales P2,393,250

Cost of Sales 1,313,600
Gross Profit P1,079,650
Operating Expenses 586,040
Operating Profit P 493,610
Finance Costs 38,400
Profit P 455,210

Figure 4.2 – Parts of an Income Statement

for a Merchandising Entity

Source Documents
Merchandising business use various business forms and documents to help identify the
transactions that should be recorded in the books. These source documents contain
vital information about the nature and amount of the transactions.
1. Sales Invoice is prepared by the seller of goods and sent to the buyer. This
document contains the name and address of the buyer, the date of sale and
information – quantity, description and price – about the goods sold. It also
specifies the amount of sales, and the transportation and payment terms.
2. The Bill of Lading is a document issued by the carrier – a trucking, shipping or
airline – that specifies contractual conditions and terms of delivery such as freight
terms, time, place, and the person named to receive the goods.
3. The Statement of Account is a formal notice to the debtor detailing the accounts
already due.
4. The Official Receipt evidences the receipt of cash by the seller or the authorized
representative. It notes the invoices paid and other details of payment.

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5. Deposit Slips are printed forms with depositor’s name, account number and
space for details of the deposit. A validated deposit slip indicates that cash with
the supplied details were actually deposited or credited to the account holder.
6. A Check is a written order to a bank by a depositor to pay the amount specified in
the check from his checking account to the person named in the check.
7. The Purchase Requisition is a written request to the purchaser of an entity from
an employee or user department of the same entity that goods be purchased.
8. The Purchased Order is an authorization made by the buyer to the seller to
deliver the merchandise as detailed in the form.
9. Receiving Report is a document containing information about goods received
from a vendor. It formally records the quantities and description of the goods
delivered.
10. A Credit Memorandum is a form used by the seller to notify the buyer that his
account is being decreased due to errors or others factors requiring adjustments.
Steps in a Purchase Transaction
Whenever a purchase or sale of merchandise occurs, the buyer and the seller should
agree on three things, namely:
 the price of the merchandise,
 the payment terms and
 the party to shoulder the transportation cost.
Owners of small merchandising firms may settle these terms informally by phone or by
discussion with the vendor’s representative. Most large businesses, however, follow
certain procedures when purchasing merchandise. The procedures are as follows:
1. When a certain items are needed, the user department fills in a purchase
requisition form and sends it to the purchasing department.
2. The purchasing department then prepares a purchase order after checking with
the price lists, quotations, or catalogs of approved vendors. The purchase order,
addressed to the selected vendor, indicates the quantity, description, and price of
the merchandise ordered. It also indicates expected payment terms and
transportation agreements.
3. After receiving the purchase order, the seller forwards an invoice to the
purchaser upon shipment of the merchandise. The invoice – called a sales
invoice by the seller and a purchase invoice by the buyer – defines the terms of
the transaction.
4. Upon receiving the shipment of merchandise, the purchaser’s receiving
department sees to it that the terms in the purchase order are complied with, and
prepares a receiving report.
5. Before approving the invoice of payment, the accounts payable department
compares copies of the requisition, purchase order, receiving report and invoice
to ensure that quantities, descriptions, and prices agree.

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When goods are received or when title has passed, the entity should record purchases
and a liability (or a cash disbursement). Generally, the seller recognizes the sales
transaction in the records when the goods have been shipped.
Terms of Transactions
Merchandise may be purchased and sold either on credit terms or for cash on delivery.
When goods are sold on account, a period of time called the Credit Period is allowed for
payment. The length of the credit period varies across industries and may even vary
within an entity, depending on the product.
When goods are sold on credit, both parties should have an understanding as to the
amount and time of payment. These terms are usually printed on the sales invoice and
constitute part of the sales agreement. If the credit period is 30 days, then payment is
expected within 30 days from the invoice date. The credit period is usually described as
the net credit period or net terms. The credit period of 30 days is noted as “n/30”. If the
invoice is due ten days after the end of the month, it may be marked “n/10 eom”. (‘eom’
- means ‘end of month’)
Cash Discounts
Some businesses give discounts for prompt payment called Cash Discounts. If a trade
discount is also offered, cash discount is computed on the net amount after the trade
discount. This practice improves seller’s cash position by reducing the amount of money
in accounts receivable. Cash discount is designated by such notion as “2/10” which
means the buyer may avail of a two percent discount of the invoice is paid within ten
days from the invoice date. The period covered by the discount, in this case – ten days,
is called the Discount Period.
Cash discounts are called Purchase Discounts form the buyer’s viewpoint and Sales
Discounts form the seller’s point of view.
It is usually worthwhile for the buyer to take the discount if offered although it may be
necessary to borrow the money to make the payment.
Illustration: Assume that an invoice for P150,000 with terms 2/10, n/30, is to be paid
within discount period with money borrowed for the remaining 20 days of the credit
period. If an annual interest rate 18% is assumed, the net savings to the buyer is
P1,530 which is determined as follows:
Cash discount 2% on P150,000 P3,000
Interest for 20 days at an annual rate of 18% on the
Amount due within the discount period:
P147,000* x 18% x 20/360 1,470
Savings Effected by Borrowing P1,530
*Amount Due = P150,000 Invoice price – P3,000 Cash Discounts
Trade Discounts

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Suppliers furnish smaller wholesalers or retailers with price lists and catalogs showing
suggested retail prices for their products. These firms, however, also include a schedule of trade
discounts from the listed prices to enable the customer to determine the invoice price to be paid.
Trade Discounts encourage the buyers to purchase products because of markdowns from the
list price. Trade discounts should not be confused with cash discounts. This type of discount
enables the suppliers to vary prices periodically without the inconvenience of revising price lists
and catalogs.
There is no trade discount account and there is no special accounting entry for this discount.
Instead, all accounting entries are based on the invoice price which is obtained by subtracting
the trade discount from the list price.
Illustration: Pinnacle Technologies quoted a list price of P2,500 for each 64 gigabyte flash drive,
less a trade discount of 20%. If Video Fantastic ordered seven units, the invoice price would be
as follows:

List Price (P2,500 x 7) P17,500

Less: 20% trade discount 3,500
Invoice Price P14,000
Trade discounts may be stated in a series. Assume instead that the trade discount
given by Pinnacle to Video is 20% and 10%, the invoice price will be:
List price (P2,500 x 70) P17,500
Less: 20% trade discount 3,500
Balance P14,000
Less: 10% trade discount 1,400
Invoice Price P12,600
In the first example, both the buyer and the seller would record only the P14,000 invoice
price while the second example, the invoice price will be P12,600.
Transportation Costs (Delivery Expense)
When merchandise is shipped by a common carrier – a trucking entity or an airline – the
carrier prepares a freight bill in accordance with the instructions of the party making the
shipping arrangements. The freight bill designates which party shoulders the costs, and
whether the shipment is freight prepaid or freight collect.
Freight bills usually show whether the shipping terms are FOB shipping point or FOB
destination. F.O.B. is an abbreviation for “free on board”. When the freight terms are
FOB shipping point, the buyer shoulders the shipping costs; ownership over the goods
passes from seller to the buyer when the inventory leaves the seller’s place of business
– the shipping point. The buyer owns the goods while in transit and therefore, shoulders
the transportation costs.
If the terms are FOB Destination, the seller bears the shipping costs. Title passes only
when the goods are received by the buyer at the point of destination; while in transit, the
seller is still the owner of the goods so the seller shoulders the transportation costs.

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In Freight Prepaid, the seller pays the transportation costs before shipping the goods
sold; while Freight Collect, the freight entity collects form the buyer. Payment by either
party will not dictate who should ultimately shoulder the costs.
Normally, the party bearing the freight costs pays the carrier. Thus, goods are typically
shipped freight collect when terms are FOB shipping point; and freight prepaid when the
terms are FOB destination.
Advance Information:
The shipping costs borne by the buyer using the periodic inventory system are debited
to transportation in (freight in) account. In accounting, the cost an asset – the
merchandise inventory – includes all costs (e.g. shipping costs) incurred to bring the
asset to its intended use. In the cost of sales section of the income statement, the
balance in this account is added to purchases in computing for the net cost of
purchases for the period.
Shipping costs borne by the seller are debited to transportation out (freight out) account.
This account which is also called delivery expense, is an operating expense in the
income statement.

Questions

1. Describe the nature of a merchandising business.

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2. What is the difference between the income statement of a service entity

and of a merchandising entity?
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3. Differentiate trade discounts from cash discounts.

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4. Kindly compare and contrast the operating cycle of a merchandising

business and a service business.
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Activity

Search for the sample of the 10 source documents that are used in a
merchandising business. It can be taken from the internet or from a photo of
cell phone, pasted in a short bond paper. One sample each source document.

Quiz
A. Direction: Find the answer and include the corresponding computation for each
item.
1. On June 1, 2016, Marry Thes Products sold merchandise with a P120,000 list
price.
Trade Discount Credit Terms Date Paid
a. 30% 2/10, n/10 June 8
b. 40% 1/10, n/30 June 15
c. - 2/10, n/30 June 11
d. 20% 1/15, n/30 June 14
e. 40% n/30 June 28
Required: For each sales terms, determine the following:
i. The amount recorded as sale.
ii. The amount of cash received.

Answer:

B. Direction: Put the right answer to the following columns.

Freight Terms Who should shoulder the Who Pays the
Transportation Costs? Shipper?
FOB Destination, Freight Prepaid
FOB Shipping Point, Freight Collect
FOB Destination, Freight Collect

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FOB Shipping Point, Freight Prepaid

Reflection
As an accounting student what did realize in the lesson?
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References

Book:
Ballada, Win. 2017. Fundamentals of Accountancy Business & Management
1. Manila, Philippines. DomDane Publishers. pp. 197-200.

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